Quick background: AT&T price is down
It’s not really surprising that AT&T (NYSE:T) is down this year. Here’s a quick overview:
It’s a weird sight. Here’s why. On April 11, AT&T finalized the spin-off of Warner Bros. Discovery (WBD). Depending on how you think about it, that was a few days or years ago. There’s a whole time warp around the WBD spinoffs. At least, that’s how I feel. Either way, here’s a better way to see T, starting April 12.
It is a much truer view. And, interestingly, here’s how it compares to the S&P 500 (SPY), in case you were wondering.
Really, there is almost no difference. Basically, and on the surface only, you’re better off owning SPY for diversification and a smaller capital loss. On the other hand, you’d probably be better off with T if you’re looking for income. Here is a simple view that aggregates capital gains and losses with return.
This is very important because it shows that there is often not much difference between a single stock and the market. However, sometimes you can get a big return while holding just one stock. On the other hand, you can potentially reduce your risk by holding the whole market through an ETF or mutual fund. Choose your poison based on your goals, your schedule, and the rest of your wallet.
It’s the context. Now, in the rest of this article, we’ll dig into free cash flow and T’s dividend. But first, let’s explore the big picture and how we got here.
What about risk?
Let’s spend a moment digging into risk, because high capital returns and high dividends can mask risk. First of all, to be clear, I’m not a fan of MMT, or Modern Monetary Theory. Second, I disagree with the idea that volatility is the best definition of risk. With these points in mind, I think it is instructive to consider how much stocks are moving relative to the overall market.
Below you will see SPY, T and Alphabet (GOOGL). The measurement starts on April 12, so it’s after the WBD spin-off. In any case, you will see that GOOGL is higher than SPY and T is lower than SPY. Take a look, then I’ll explain.
Here’s how to understand the math of the beta here:
The S&P 500 is an unmanaged index generally considered representative of the US stock market and has a beta of 1. A stock with a beta of 1 means that on average it moves in line with the S&P 500 – the stock is expected to rise by 10 % when the S&P 500 rises 10% and falls 10% when the S&P 500 falls 10%. A beta greater than 1 indicates the stock is expected to rise or fall by more than the stock market moves, while a beta below 1 means the stock is expected to rise or fall by less than the S&P 500. Since beta measures movement on average, you cannot expect an exact correlation with every market movement.
In summary, SPY is basically a representation of the market, so it is very close to 1. On the other hand, GOOGL will rise faster and fall faster than the market, while T will rise slower and fall slower than the market . In simpler terms, GOOGL is going to be more volatile than the market, and the market is more volatile than T.
We can now properly proceed to the critical update. Specifically, I’m talking about AT&T’s free cash flow, given Q2 2022 news.
Damage to free cash flow but not to dividends
In June, I issued a free cash flow yield alert. In this article, I posted this little gem for the readers:
AT&T is steering free cash flow expansion into 2023 and beyond, both through adjusted EBITDA growth and reduced capital expenditures. EBITDA is expected to grow 6% in 2023, following 3% growth this year, and capital spending is expected to fall nearly 17% in 2024 to $20 billion, as deployment spending eases of 5G.
Some time has passed, so we can now examine the Q2 2022 earnings call for clues. There’s good news and bad news, all in one chart.
T provided clarification by raising wireless revenue estimates to 4.5% to 5% growth, but dropping free cash flow by $2 billion.
Here is the footnote for your reading pleasure, from the horse’s mouth:
Free cash flow is a non-GAAP financial measure frequently used by investors and rating agencies to provide relevant and useful information. In 2Q22, free cash flow was cash flow from operating activities of continuing operations of $7.7 billion, plus cash distributions from DIRECTV classified as investing activities of $0.3 billion , less capital expenditures from continuing operations of $4.9 billion and cash paid for supplier financing of $1.8 billion. Due to the high variability and difficulty in predicting the items that impact cash flow from operating activities, DIRECTV’s cash distributions, capital expenditures and vendor financing payments, the company is unable to provide a reconciliation between projected free cash flow and the most comparable GAAP measure without unreasonableness. effort.
During the results call, we learned the following:
- T’s ambitious investment plans are expected to total $24 billion.
- T pre-programmed capital investment plans to launch growth initiatives.
- T expects these plans to moderate over the course of the year.
So we know why Q2 was a bit more cash-intensive. And that sounds good, but there are also headwinds:
- Longer collection cycles
- Rising inflationary pressures
- Macroeconomic weakness expected
According to my reading, these headwinds should eat away at about $2 billion in cash flow. The simple math is that the FCF takes a 15-20% hit, as the expected FCF of T drops from $16 billion to $14 billion.
Either way, here’s what matters to most T investors. The dividend isn’t in jeopardy. The dividend is $1.11, which will likely be 58-62% of projected free cash flow per share in 2022. Maybe my range isn’t big enough, but the fact is that the dividend of T is safe and the yield is close. at 6.5% if you are looking to collect.
If I was looking for current income, I would consider T at these prices. It’s marginally a buy, although I’m much more interested in other companies right now. In fact, I deliberately pointed to GOOGL because it’s a better company. Longer term, I expect GOOGL to beat T in terms of total return. But, T absolutely crushes companies like GOOGL if you need dividends and income, just because GOOGL pays nothing. You can just sell small chunks of GOOGL to generate revenue, but that’s a topic for another day.
So, still interested in T, huh? Well, here’s some more good news. T’s CFO Pascal Desroches had this to say in Q1 2022, and I haven’t seen an update since:
Now, let’s take a step back and look at the expected free cash flow generation from our business. As reported on our Analyst Day, we expect to generate approximately $20 billion of free cash flow in 2023. After paying dividends and minority interest commitments, we expect at least $10 billion in cash to remain. [Emphasis: Author]
Again, there’s enough to like about what T is doing. And T’s dividend is very healthy right now. Well, healthy enough not to expect a freeze or a cut.
T is a reasonable buy at this price for income investors. But, of course, other options like GOOGL are superior to T in terms of long-term capital gain potential, and therefore total return opportunity.